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Chicago Tribune Gail MarksJarvis column [Chicago Tribune :: ]

(Chicago Tribune (IL) Via Acquire Media NewsEdge) March 26--With the first quarter of the year about to end, the lesson of the stock market over the last three months has been: Don't peek.

In contrast to 2013, this seems to be a year of volatility, with market swings trying the nerves of individuals who fixate on their 401(k) or other investments each day. The Standard & Poor's 500 is up about 1 percent for the year, but nervous individuals were tormented along the way. Stocks plunged about 6 percent early in the year, recovered, then plunged temporarily again last week after the new Federal Reserve chair, Janet Yellen, implied interest rates might start rising by April 2015.

That date, though still not definite, was earlier than many investors were anticipating and forced investors to imagine a time when the Fed would no longer stimulate stock market gains.

As investors continue to keep watch for those rising rates, stocks are likely to be whipsawed.

The reason: 2014 is being viewed as a transition year. About six years of coddling from the Federal Reserve is expected to come slowly to an end, and as investors anticipate higher interest rates, momentary scares are likely to set off knee-jerk moves in the stock market. Higher rates make it more expensive for businesses and individuals to borrow money, and investors worry that can cut corporate profits and deter individuals from buying homes.

In contrast, the low rates of the last few years have made cheap money available and enticed investors to buy stocks. Last year, stocks rose 30 percent as investors were able to sit back and count on the Fed to help bolster the stock market with low rates even when the economy and corporate profits weren't impressive.

But with the Fed less benevolent, the economy and the quality of the profits companies generate will take on more importance in investor decisions. It's no longer a no-brainer investing environment.

"2014 will represent the start of a transitional period where investors depend less on quantitative easing by the Fed, and more on traditional fundamentals such as cash flow and earnings," said BMO Capital Markets strategist Brian Belski. "Given that an entire generation of investors has built careers the past 10 to 15 years around the notion that the Fed and low rates drive stock performance -- not fundamentals -- periods of increased volatility were going to inevitably coincide with any change in direction or tone from the Fed."
Still, rising rates alone don't mean danger for stock investors unless the economy and corporate profits abruptly sour or rates shoot up suddenly. Most economists think the U.S. economy will improve further this year and next, and that will help companies generate profits that match the optimistic expectations reflected in high stock prices.

"Our economics team sees a favorable environment for corporate profits with a significant pickup in U.S. (gross domestic product) and productivity growth in 2014, with only modest pickup in wage growth," said Goldman Sachs strategist Amanda Sneider in a recent report to clients.

Goldman Sachs is anticipating that the Standard & Poor's 500 will end this year at 1,900, up from Tuesday's close of 1,865.62, and end 2015 at 2,100.

But the stock market might not make those gains without twinges of angst and downturns.

The S&P Capital IQ Investment Policy Committee recently noted, "U.S. stocks appear to be priced for perfection." And when stocks are pricey, unnerving events can set off sell-offs.

The stocks of the Standard & Poor's 500 are priced at about 17 times the earnings they are expected to produce. That's above the 14 times that's average, and when stocks are pricey, that can set off downturns.

If expectations for corporate profits erode, investors will become reluctant to buy stocks amid declines, and that could exaggerate any downturns.

A recent survey of global fund managers by Bank of America Merrill Lynch showed professional investors worldwide most worried about geopolitical tension and the possibility that financial problems in China could lead to weak earnings in emerging markets.

To avoid the potential impact, some investors have been favoring midsize U.S. stocks, which depend less than large company stocks on selling into foreign markets. The Standard & Poor's MidCap 400 index is up about 2 percent this year. Investors during the last few days have also moved some money from the priciest sectors such as biotechnology and into more defensive sectors such as telecommunications services.

But with stocks climbing again after the brief nervousness around Fed Chair Yellen's hint of higher interest rates last week, Standard & Poor's strategist Sam Stovall said investors might have recovered their courage as they examined history.

"Most asset classes historically performed relatively well, despite a rise in rates," he said. After rising substantially, however, "rates do pose a problem." For stocks, "the line in the sand has historically been 6 percent."
gmarksjarvis@tribune.com
Twitter @gailmarksjarvis
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